stion Th (a) The following information relates to Pine Wholesalers for the year

Question

stion Th (a) The following information relates to Pine Wholesalers for the year ended 31 December, Inventory Accounts receivable Accounts payable Beginning of year (Shs. Millions) 2,000 600 500 End of year (Shs. Millions) 2,300 800 300 Sales in the year were shs. 11.5 billion, of which 60% were on credit. Cost of goods sold to sales ratio was 85:100. Cash purchases were 30% of credit purchases Required: (i) The cash cycle for Pine during the year 2015. [11 marks] (i) What steps can Pine take in order to reduce the operating cycle? [5 marks]

Explanation / Answer

Answer i Cash cycle = Days Inventory Outstanding + Days Sales Outstanding - Days Payables Outstanding Days Inventory Outstanding = 365 days / Inventory turnover ratio Inventory Turnover ratio = Cost of goods sold / Average Inventory Cost of goods sold = Sales * 85% = Shs.11.5 billion * 85% = Shs.9.775 billion i.e.Shs.9775 millions Average Inventory = (Shs.2000+Shs.2300)/2 = Shs.2150 millions Inventory Turnover ratio = Shs.9775 million / Shs.2150 million = 4.55 Days Inventory Outstanding = 365 days / 4.55 = 80.28 days Days Sales Outstandings = 365 days / Receivable Turnover Ratio Receivable turnover ratio = Credit sales / Average Receivable Credit sales = Shs.11.5 billion * 60% = Shs 6.9 billion i.e.Shs 6900 millions Average Receivable = (Shs 600 + Shs 800)/ 2= Shs 700 million Receivable turnover ratio = Shs 6900 / Shs 700 = 9.86 Days Sales Outstandings = 365 days / 9.86 =37.03 days Days Payables Outstandings = 365 days / Accounts Payable Turnover Accounts Payable turnover ratio = Credit Purchases / Average Accounts Payables Credit Purchases = Cost of Goods sold * 70% = Shs 9775 millions * 70% = Shs 6842.50 million Average accounts Payables = (Shs 500 + Shs 300)/2 = Shs 400 millions Accounts Payable turnover ratio = Shs 6842.50 / Shs 400 = 17.11 Days Payables Outstandings = 365 days / 17.11 = 21.34 days Cash cycle = 80.28 days + 37.03 days - 21.34 days = 95.97 days Answer ii Steps taken to reduce the operating cycle : 1) Getting the creditors to extend the repayment period beyond that will allow you to have more cash. 2) Encouraging cutomers to pay faster by offering them some type of incentive to pay sooner rather than later. 3) Through automation of billing and invoicing process cash cycle can be reduced. 4) Proper Inventory Management

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